Estimate Time3 min

How tax brackets work

It’s a pretty common misconception that your tax bracket represents how much of your income you’ll have to pay in federal income tax. But that’s not how tax brackets work.

Americans have a progressive tax system with rates that rise along with income, so the higher your income, the higher your tax bracket. No one really pays the top tax bracket percentage on every dollar of their taxable income. Usually, it’s a much lower amount.

Let’s look at a hypothetical example.

How tax brackets work

Cyrus lands a great job making $90,000 a year. Yay!

Illustration shows young man sitting at a computer looking happy.

He looks at the 2023 IRS tax brackets for single filers to see where his $90,000 income falls and is a little alarmed to see his income fall into the 22% tax bracket.

Graphic shows Cyrus’s income initially falling near the top of the 22% tax bracket. In addition, he has $8,000 in income from a side gig that nudges him into the 24% tax bracket.

(Tax brackets above $182,100 are not illustrated here. Here’s where you can check out the 2023 and 2024 marginal tax rates.)

Does this mean Uncle Sam gets 24% of Cyrus’ hard-earned money this year? Not quite.

Different types of tax rates

Before we talk about why Cyrus shouldn’t panic, let’s stop to define a few of the ways people talk about income tax rates (in this case, federal).

  • Tax rate: A percentage of your income the government claims for taxes. Without more detail, the phrase is mostly meaningless.
  • Marginal tax rate: The rate you’ll pay on your last (highest) dollar of income. For Cyrus, that’s 24%. Here’s how you can calculate your own marginal tax rate.
  • Effective tax rate: The actual percent of your gross income you pay once you’ve reduced your income with deductions and filed your taxes. This rate is generally much lower than your marginal tax rate.

OK, now let’s get back to that 24%.

It’s helpful to think of these income ranges as falling into buckets rather than brackets. Each bucket holds a different amount of money that’s taxed at a different rate. When the first one fills up, your income spills over into the next one, and so on.

Illustration shows how tax brackets work by using buckets as an example. The first $11,000 of income falls into the first bucket (10% tax rate), the next $33,725 falls into the next bucket (12% tax rate), the next $50,650 in a third bucket (22% tax rate), and the next $86,725 in the fourth bucket (22% tax rate).

That’s how it works in theory, but no one pays taxes on every dollar of their income. Cyrus contributes to a 401(k) and a Health Savings Account, which help reduce his taxable income—in other words, he can scoop it out of those buckets.

Illustration shows his $3,000 HSA contribution and $9,000 401(k) contribution. These are above-the-line tax deductions, items that are subtracted from gross income in order to calculate adjusted gross income.

(The maximum contributions to both his 401(k) and his HSA are much higher. If he maxxed out both in 2023, he could reduce his taxable income by more than $26,000. And if he didn’t have a 401(k) through work, he could contribute to a traditional IRA instead.)

And then there are other deductions he takes when it comes time to file his taxes. As a single filer with a simple return, Cyrus takes the standard deduction—a bigger scoop out of the bucket. (If he had mortgage interest, big state and local tax bills, or significant charitable contributions, he might be able to deduct even more by itemizing those write-offs.)

Illustration shows his standard deduction of $13,850. The standard deduction is a portion of your income that is not subject to tax and can be used to reduce a tax bill instead of itemizing deductions on your return.

Let’s see what these deductions do to Cyrus’ taxable income:

Graphic shows the math: Subtracting a $9,000 401(k) contribution, $3,000 HSA contribution and $13,850 standard deduction brings Cyrus’ taxable income to $72,150, well below the $95,375 threshold for the 24% tax bracket.
Graphic shows how his income would be taxed: $11,000 at 10%, #33,725 at 12%, and $27.425 at 22%, bringing his total tax bill to $11,181.

What is an effective tax rate?

After deductions, Cyrus’s marginal tax rate is 22% (the biggest bucket his income falls into). But that’s still not his effective tax rate, the actual percent of his gross income he pays, after deductions.

To get there, we do just a little more math:

Graphic shows the math, dividing his $11,181 taxes owed by his $98,000 total income, to get 0.114, and then converting the result to a percentage by multiplying by 100.

That gives Cyrus an effective tax rate of 11.4%, far from the 24% he feared he would owe.

For details on tax rates and how to minimize your effective tax rate, read Viewpoints: 2023 and 2024 tax brackets and federal income tax rates.

Ready to start saving or investing?

Choose from a variety of different accounts to help you meet your goals.

More to explore

Tips on taxes

Ideas to help lower taxes on income, investments, and savings.

This information is intended to be educational and is not tailored to the investment needs of any specific investor.

The images, graphs, tools, and videos are for illustrative purposes only.

Fidelity does not provide legal or tax advice. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Fidelity cannot guarantee that the information herein is accurate, complete, or timely. Fidelity makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation.

Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917